Luis Manuel C. Méjan
I. The Concept of Discharge
The focus of this Newsletter is to compare the approaches taken by different jurisdictions regarding the limits of debt discharge, also known as “exoneration” or, more commonly in international contexts, by its English term “discharge.”
This practice fundamentally corresponds to what the General Theory of Obligations describes as: “Forgiveness” or “Remission” (when the creditor informs the debtor that they are released from the duty to fulfill their obligation); “Waiver of the exercise of a right” (when the creditor allows deadlines for enforcement or prescription to lapse without acting); or “Novation” (when creditor and debtor jointly agree to terminate a legal obligation and replace it with a new one).
The figure of discharge usually appears at the conclusion of an insolvency proceeding, when a restructuring agreement has been reached that creates a new framework of rights and obligations between the debtor and their creditors. This is more accurately described as a reorganization of the debtor’s financial situation, and the legal characterization is novation—some obligations are extinguished and replaced by others. This model is typical of over-indebtedness in commercial entities seeking to remain economically active as contributingagents.
When it comes to natural persons, who are not typically engaged in business or commercial activities, the focus is different. A natural person can never be removed from the economy; they cannot be «liquidated» and “terminated”—their assets may be seized and disposed of, but they must continue to generate wealth, as they need it for their survival.
In cases of generalized over-indebtedness, creditors will take hold of the debtor’s assets (excluding certain items specially protected by law for humanitarian reasons), convert them into cash, and use the proceeds to satisfy debts—according to their rank and preference as set out in law.
What happens when the debtor’s assets are insufficient to cover their total debts? Creditors will look at the debtor’s future economic activity and estimate the income that might be received, aiming to allocate a portion of that income to gradually pay the outstanding debts as they arise.
Financially, the concept is valid: it’s about locating a repayment source and reorganizing the obligation through write-downs, grace periods, interest reductions, etc., to make the obligation feasible.
However, when the expected income is too low to cover both the debtor’s (and likely their family’s) basic needs and the outstanding debts, the repayment plan becomes an unbearable burden. It also removes the natural human incentive to work in pursuit of satisfaction and progress.[1]
This logic introduces the concept of discharge, often referred to as a “Fresh Start” or “Clean Slate,” which is appealing to those facing financial crisis. It allows for the reintegration of an individual into economic life, even though it may represent a loss or nullification of rights for the creditors.[2]
This presents a dilemma of justice and human rights—one that insolvency legislation must address.
One path is to establish that what is paid does not extinguish the creditor’s right, leaving the debt alive in case the debtor acquires new assets in the future, allowing the creditor to enforce their rights—provided prescription or forfeiture periods have not elapsed. Even in such cases, the debts might become natural obligations (those that are no longer legally enforceable but whose payment is considered valid).
Another path is to regulate the extinction of the obligation through the granting of a discharge—whether full, partial, or conditional. Within this framework, there will always be debts excluded from discharge (e.g., tax or labor debts).
Recently, the Fifth Circuit of the U.S. Bankruptcy Courts ruled:
“Discharging and extinguishing claims are different. Discharge does not extinguish a debt. Indeed, a debt survives discharge. A discharged debt can be revived by reaffirmance, and discharge gives rise to an affirmative defense that can be waived.”[3]
II. Discharge, Good Faith, Bad Faith, and Perverse Incentives
The discharge mechanism can create undesirable side effects—namely, perverse incentives. The World Bank has expressed concern about the moral hazard involved in offering debtors a way to act irresponsibly with minimal consequence.[4]
This risk is heightened when discharge is exploited by repeat debtors:
“It worked for me last time—I’ll rack up debt again, and eventually it’ll be written off.”
This constitutes bad faith, which the law must not tolerate.
Bad faith involves intentional dishonesty—acts meant to deceive or take undue advantage, including misinformation or manipulation.
Discharge must not be granted when the insolvency process is used to defraud creditors. Standards of evidence for bad faith vary by jurisdiction, making comparative analysis highly valuable.
Measures used by various jurisdictions to ensure good faith in discharge include:
- Listing debts that are never dischargeable, in whole or part
- Defining eligible and ineligible individuals for discharge
- Requiring partial payment of debts
- Imposing waiting periods before repeat discharge can be sought
- Establishing rehabilitation principles:
Excessive debts should be lifted
No future discrimination due to past discharge
Debtors must avoid future over-indebtedness - Providing incentives for regular payment plans (e.g., larger discharge if debtor complies over time)
Other mechanisms may apply depending on the legislator’s vision.
III. Cross-Border Insolvency Cases
Discharge becomes particularly complex in international insolvencies. Must a discharge granted in one country be recognized in another?
In principle, if the discharge is granted under the main proceeding, the lex fori concursus should prevail, and other jurisdictions should recognize the decision.
However, local standards of good or bad faith will still influence whether the discharge is accepted abroad.
Luis Manuel C. Méjan
Mexico City, June 2025
About the author: Doctor of Law. Former General Director of the Federal Institute for Commercial Insolvency Specialists (Mexico).
Active member of the International Insolvency Institute.
Renowned lawyer specializing in insolvency and restructuring, with extensive academic and professional experience in Mexican insolvency law.
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[1] Obliga recordar aquella canción de los años 50: Sixteen Tons: “St. Peter don’t you call me ‘cause I can’t go, I owe my soul to the Company Store”
[2] INSOL INTERNATIONAL. Protocol for International Recognition of Insolvency Proceedings Affecting Natural Persons. London, Page 9. “…the concept of a discharge of debt in a reasonable amount of time so that individuals may continue with their lives without having to earn their living in legal limbo.”
[3] abi.org/newsroom/daily-wire/plan-didn’t-extinguish-debts-only-discharged-them-fifth-circuit-says
[4] The World Bank. Report of the Working Group for the Treatment of the Insolvency of Natural Persons. Report No: ACS6818. Insolvency and Creditor/Debtor Regimes Task Force. The World Bank. Washington, D.C. Page 41
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